In a little more than ten weeks, new rules go into effect that require municipal securities dealers to disclose the mark-ups and mark-downs they charge when selling municipal bonds to retail investors. Despite a significant notice and comment period, the provision of a year and a half of lead time, and considerable substantive guidance, bond traders are said to be scrambling to meet the May 14th implementation date. They may yet get some relief. Here’s a closer look at where things stand:

NEW RULES FOR BOND PRICE DISCLOSURES

In November, 2014, the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB) published potential new rules requiring bond dealers to disclose price information for transactions in fixed income securities. Those draft rules were a response, in part, to a set of 2012 SEC recommendations to consider such disclosure. The self-regulatory organizations’ (SRO) proposals were based on a demand to improve transparency in the bond markets by addressing concerns related to mark-ups in so-called “riskless principal transactions.” (MSRB defines the term as “a matching pair of purchase and sale transactions in a municipal security executed by a dealer as principal, under circumstances where such matched transactions effectively eliminate principal risk to that dealer.”)

After extensive comment, in late November 2016, the MSRB received approval from the SEC for a proposed change to MSRB Rule G-15 on confirmation, clearance, settlement and other uniform practice requirements with respect to customer transactions, and MSRB Rule G-30, on prices and commissions. The MSRB concluded that the new disclosures will “provide meaningful and useful pricing information to retail investors and may result in lower transaction costs for such investors.”

MSRB AND FINRA PROVIDE INTERPRETIVE GUIDANCE

In July, 2017, the MSRB issued interpretive guidance (Regulatory Notice 2017-12) explaining how the new rules would apply to different trading situations. The guidance provides information on confirmation disclosure requirements and the calculation of “prevailing market prices” (PMP) for the purpose of determining mark-ups and other Rule G-30 determinations. (For an early analysis of the issues associated with PMP determinations, see archived Bates’ blog here by Bates Municipal Securities Expert Pamela Peterson). Although the new Rules and guidance require mark-up/mark-down disclosure only for a fairly limited set of transactions, and the guidance is actually quite helpful in setting algorithm characteristics for determining PMP, the problem of “no comparable transaction can be found” has not simply disappeared. The million-plus outstanding municipal CUSIPs will continue to frustrate the efforts of programmers to automate determination of PMP for every retail-sized transaction. FINRA released coordinated and similar confirmation disclosure requirements for other areas of the fixed income markets under FINRA Rule 2121. (A good recap of the MSRB guidance can be found here.)

THE STATE OF READINESS

There are still significant objections to the May 14th implementation date for the new rules. In November it was reported that “many in the industry worry they will not be able to put in place the changes that will allow their automated systems to comply with the new requirements.” There are several reasons given for this concern, the first being the difficulty in providing mark-up disclosures both “as a total dollar amount and a percentage of the prevailing market price.” Second, as noted above, there is continuing concern about the difficulty in determining the PMP and the processes required to review the “waterfall” of factors that go into that determination. Third, there is worry about the confidence of in-house and vendor-automated processes from transaction to delivery of the customer confirmation. For example, as Pamela Peterson notes, “because same-day opposite-side-of-the-market transactions must be considered in setting PMP, a dealer who buys a retail-size bond position in the morning and sells it to another retail customer late in the day is faced with questions about whether to immediately process the first confirmation or not. The second transaction could require re-consideration of PMP for the first transaction. It’s hard to know whether it’s better to confirm using straight-through processing and correct later, or hold confirmations till the end of day.”

Dealers are on the hook for these deliverables, and, under the rules, they will not be able to offer “estimated” or “approximate” price confirmations. As late as last November, many municipal dealers were still looking for technology vendors who could assist in providing some of these solutions. Both the Bond Dealers of America and SIFMA have made their concerns known to the regulators and are in a continuing dialogue about the state of compliance with dealer firms.

REGULATORS CONTINUE TO OFFER HELP

MSRB continues to provide education and resources to support firms’ efforts to be prepared by the implementation date. The SROs’ position is that the operational challenges for dealers are limited and that compliance by the implementation date is feasible given the guidance, timeline, and regulator support provided.

That said, there has been no let-up in MSRB offering continuing and new support for firms to make the deadline. In mid-January, at its quarterly meeting, the MSRB made it known that it would issue additional guidance in the form of FAQs on implementation issues that have been raised since the issuance of the previous guidance. These are due out within a few weeks. Other educational resources are being made available as well. MuniEdPro, MSRB’s on-line courses on mark-up disclosure, are now available for free. These courses provide outlines and hypotheticals to prepare dealers for different compliance scenarios.

CONCLUSION

Notwithstanding the efforts undertaken by the MSRB, dealers are still advocating for an extension of the implementation date for the MSRB mark-up disclosure requirements. In a letter to the SEC earlier this month, the Bond Dealers of America proposed various ways to address implementation concerns including a proposal to allow a firm to submit a “business plan” showing that they are “develop[ing] an implementation plan pursuant to which the dealer establishes a specific schedule that provides the dealer a reasonable basis that it will comply with the Retail Disclosure Rules on or before December 31, 2018.” It is hard to see how that offer would appeal to the SEC, given the lengths to which the SROs have gone to demonstrate support for the industry to meet the deadline. That said, limited relief through short term extensions might be preferable for both regulators and firms rather than a host of enforcement actions to clarify the rules. Bates will continue to keep you apprised of any new developments.